It's About Time

It may have lacked the hoopla of a midnight Harry Potter release, but in retirement industry circles, last week’s publication of the Department of Labor’s final regulations on qualified default investment alternatives (QDIAs) was nearly as eagerly anticipated.

And, like the speculation as to which Potter character would survive the latest saga, the early betting had been that stable value would not make the QDIA cut—and, in large part, that turned out to be the case. Instead, stable-value (or more precisely, capital preservation) vehicle proponents had to content themselves with a sanction as a short-term repository for contributions (up to 120 days—long enough to accommodate the 90-day period that defaulted participants have to opt out), and the assurances from the DoL that they were sure that those vehicles would find a home alongside other options in the time-focused asset-allocation products that were accorded QDIA status (ironically, IMHO, in that regard, capital preservation vehicles seemed to fare better than did pure risked-based allocation fund alternatives).

There was, however, at least one significant victory for capital preservation vehicles: the DoL’s final regulation extends the same QDIA status protections to defaulted contributions made to those vehicles prior to December 24, 2007, the effective date of the new regulations. To some, that decision smacked of a “sellout” by the DoL—and it certainly seems a striking inconsistency considering the clear preference accorded diversified, age-based funds in the regulations. As one adviser remarked to me last week, “What was the DoL thinking?”

Frankly, while the decision initially surprised me as well, the longer I consider it, the better I like it.

Considering the inertia associated with the choice of these selections, there is every possibility that plan sponsors permitted the flexibility to leave those existing default options in place will do exactly that—a result that certainly has to be a concern for those who question the prudence of those investments over the long term.

Consider the Alternatives

But consider what the result might have been had the DoL not provided that flexibility. We could well have had to absorb millions, if not billions, of defaulted investment liquidations—movement that could have had severe financial consequences for the market(s), and potentially for the plans that would be presented with huge surrender charges. Spared those charges, it is still possible that that massive shift of money could have occurred – departing their current positions—and entering new ones—at an unpropitious moment.

Even if plan sponsors had decided to simply stay the course on their own (the final regulations cautioned fiduciaries that the exclusive purpose rule precluded the imposition of fees on participant balances just to achieve fiduciary protection), that decision would almost certainly—and sooner rather than later—have drawn the focus of litigators who would cite the DoL’s pronouncements as a proof statement that the investments defaulted in good faith were, in fact, imprudent.

Is this a “victory” for capital preservation proponents? Well, perhaps in the short term, but there’s no mistaking the DoL’s clear intent. The grandfather clause extends only to the balances so invested as of the effective date—not for contributions defaulted after that. Frankly, much as some plan sponsors still prefer the stable-value option (and many do)—and even though the DoL didn’t say that a capital preservation default was inherently imprudent—I think it’s reasonable to expect that these monies will begin to shift toward QDIA-sanctioned alternatives in the months ahead, as they already are. But thanks to the reasoned approach made possible by the final regulations, they will be able to do so in a measured, prudent fashion.

It was a long time coming, but, IMHO, it was worth the wait.

- Nevin E. Adams, JD

Heightened Sensibilities

I was at a conference a couple of weeks ago, when the CEO of a large, national consulting firm stood up and commented on the increased fiduciary burden that the Pension Protection Act had placed on plan sponsors – an obligation to ensure that participants’ savings are sufficient to provide an adequate retirement.

Now, in fairness, I wasn’t paying a LOT of attention to him when he stood up. He wasn’t on the panel, and I was trying to finish taking down some notes from the comments of someone who was. Nonetheless, I think I got the essence of his perspective—that PPA has created a new level of fiduciary responsibility for plan sponsors—correct.

Even if I missed some nuance in that particular instance (and I wasn’t the only one to hear it that way), I’m hearing that sentiment more and more these days—at least from the provider community.

Now, there are a lot of troubling things in the PPA for defined benefit plan sponsors, though not as bad as many feared, and certainly not as bad now that we’ve had some time to let the markets and contributions restore some of the damage from that not-so-perfect storm. But on the defined contribution side, I have always felt that the authors of the PPA had taken a Hippocratic Oath—choosing first to do no harm. The PPA took a number of existing design options—automatic enrollment, contribution acceleration, participant advice, asset-allocation funds—took into account all the areas that plan sponsors had expressed concern with over the years (how much to automatically defer, how to invest those contributions, how to return contributions for workers who wanted to opt out but didn’t, how to offer participant advice…), and provided not only a structure, but some safe harbors as well. Moreover—and IMHO, this is the best part of the PPA on the DC side—they didn’t take away a single design option, just gave us some new ones to work with.

What that means, of course, is that if you like the concept of automatic enrollment, but find that mandatory match a bit expensive—or don’t like the idea of going back and rousing those employees who never signed up years ago with an automatic enrollment notice—nothing stops you from adopting automatic enrollment on your own terms. You won’t get the protections of the safe harbor—but then, how many plans with automatic enrollment have a problem with passing their ADP test? If you still prefer (despite all the industry punditry) a stable value fund for the default—or if you just want to use a managed account that’s been put together by the plan adviser—you can still do that, even though you’ll forgo the generous protections afforded the use of a qualified default investment alternative. It’s as though the good folks in Washington finally realized they were dealing with adults, not crooks—adults who could be trusted to do the right thing(s), given the proper incentives and structure (unfortunately, the DB system wasn’t treated with the same latitude, IMHO).

However, over the past several months, I have detected a subtle shift in the dialogue about PPA. People have, in short order, gone from talking about how many people will adopt automatic enrollment to how everybody should—and I figure in another year, some will say everybody “must.” People talk about how the defined contribution system HAS to change because we’ve lost the protections of the defined benefit system—even though the vast majority of private sector American workers have NEVER enjoyed those protections. And some people—generally speaking, people in the business of selling retirement plans (though they have agents)—are beginning, in words anyway, to “convert” a plan fiduciary’s obligation to deliver a certain level of benefit via a pension plan to an obligation to ensure that the defined contribution plan fulfills that same goal.

Now, since I don’t think you can find that obligation in ERISA—or in the PPA—it gets laid at the feet of plaintiffs’ attorneys who will sue the plan fiduciary for an inadequate result, or is rationalized as “best practices” (another term that I don’t recall stumbling across in ERISA)—or, as some surely walked away from that conference saying, “I recently heard so-and-so say….”

I’d like to believe that those who are promulgating the “enhanced” obligation view are doing so for the purest of motives—that their interest lies only in helping ensure a financially satisfying retirement for all. Still, it seems to me that if they are successful in converting the already daunting fiduciary obligations of a defined contribution program to that of requiring—directly, or by inference—the ensuring of a defined benefit with a DC program, we’ll only do to the former what we are well on our way to doing with the latter.

Why Knots?

We spend a fair amount of time worrying about the relatively small percentage of workers who choose not to participate—at all, fully, or effectively—in their workplace savings plan. Well that we should, because for a myriad of reasons, they are letting a great opportunity pass them by.

However, the real crisis, IMHO, is not about the minority that we hope to stir to action with devices like automatic enrollment, tailored communications, and personal advice. Rather, the real crisis is the majority of American workers who lack even the opportunity to participate in a workplace retirement plan. Certainly, those people are on politicians’ minds, as evidenced by last week’s proposal by Senator Hillary Clinton that purports to provide "universal access to a generous 401(k) for all Americans.” Now, you can argue whether tax credits for the middle- and lower-income workers targeted will be enough to motivate them to take action, and you can certainly take issue with the price tag (and if we know nothing else about politicians of all stripes, it is that those cost projections are always “optimistic”)—but it’s hard to take issue with the need to expand the opportunity to save for retirement to everyone.

And yet, in the interests of laudable goals like “transparency,” “fairness,” and “accountability,” we have nonetheless managed to regulate private-sector retiree health care nearly out of existence, to relegate the support of private-sector defined benefit plans to the sidelines—and we are well on the way to doing the same in the public sector. In fairly short order, our once-vaunted three-legged stool now totters on the financial viability of Social Security and the ability and willingness of individual American workers to make the proper preparations.

It has its imperfections, but it’s clear that the employer-sponsored system works. We may fret about 75% participation rates, but left to their own devices—without the financial support, structure, and education of the employer-sponsored system—individual savings rates are appallingly low. We may well worry about the lack of revenue-sharing transparency and “excessive” fees paid by 401(k) plan participants, but have you taken a look lately at what you would pay for to open a retail IRA that offers a fraction of the services in your 401(k)?

As effective as that employer-sponsored system has been—as essential an element as it surely is in ensuring the retirement security of millions—we continue to undermine the willingness of employers to carry the burden. Somewhere along the way, we seem to have lost sight of the fact that these programs are voluntary, in every sense of the word. They cost money, they take time, they are subjected to an ongoing barrage of change—and, of course, there’s the ever-present threat of litigation.

Yet, we seem to expect employers to continue to support these programs, an expectation that, IMHO, borders on arrogance in view of the burdens imposed. Sure, they attract and, perhaps, allow us to retain good workers—and certainly there are modest tax incentives. But in a time when companies are driven to focus on their “core competencies,” surely we must find some more-meaningful ways to encourage those who have made the commitment to stay the course—and some compelling financial rationale for employers that have resisted the pull to join in.

We all know well why we need the employer-sponsored system. What is less obvious each day—is why a rational employer would be willing to take on the headaches currently imposed by that system.

- Nevin E. Adams, JD

The Devil in the Details

The testimony presented at last week’s hearing by the House Education and Labor Committee on the issue of 401(k) fees (see 401(k) Fee Disclosure Proposal Draws Industry Criticism at Committee Hearing) was remarkably consistent, IMHO, certainly compared with the last time the Committee took up the issue (see Congressional Committee Hears 401(k) Fee Disclosure Testimony). At a minimum, we seem to have moved past the question of whether more fee disclosure is needed to what kind of disclosures are needed, and how we can make them.

At the risk of over-generalizing the perspectives of the individuals (and individuals on behalf of groups) who shared their experience/expertise with the House Committee, it seems to me that everyone supports the following conclusions:

(1) We need a better understanding of 401(k) fees.
(2) We need more disclosure about what 401(k) fees are.
(3) We should let the Department of Labor finish their regulations on fee disclosure before doing anything legislatively.
(4) Legislation mandating a specific fund option is not a good idea (Congressman Miller’s bill, The 401(k) Fair Disclosure for Retirement Security Act of 2007, would mandate that retirement plans offer at least one lower-cost, balanced index fund in their investment lineup—see “Representative Miller Introduces Fee Disclosure Legislation”).

After the testimony had been presented, Congressman Rob Andrews (D-New Jersey) asked witness Lew Minsky, an attorney testifying on behalf of the ERISA Industry Committee, the U.S. Chamber of Commerce, the Profit Sharing/401(k) Council of America, and other organizations, what would be the problem with a specific fee disclosure to participants—a breakdown of recordkeeping, money management, and “other.” To which Mr. Minsky replied, “I’m not sure that anything is inherently wrong with it. It’s the devil in the details….”

The Right Questions

Details matter in such things, of course—not only in legislation, but also in the reality of what 401(k) plans are paying for what they are getting. Unfortunately, it frequently comes down not just to asking the questions, but to asking the right questions. Jon Chambers, an investment consultant and Principal at Schultz, Collins, Lawson, Chambers, Inc., told the committee about a situation where his firm had been engaged in a mapping study for a large 401(k) plan. In the process, they also conducted a fee reasonableness review for the plan sponsor. “The plan sponsor thought the plan fees must be reasonable, because as they reviewed each investment option, each investment option had reasonable fees,” Chambers recounted.

But the reasonableness review found that the total fees generated by the bundled arrangement currently in place were approximately $1 million higher than “necessary” under an unbundled arrangement, according to Chambers. In that case, what hadn’t been communicated (or inquired about) was the availability of a share class more appropriate for the asset size of the plan.

I hear stories like that from advisers all the time, of course. And while I don’t believe that most plan sponsors are being taken advantage of, I am nonetheless concerned that many are. How could they not be, what with the labyrinth that many must go through to simply discover what the different fee types are, much less how much they are, and who that money flows to for what services (and, IMHO, in too many cases, for WHAT services is the better question)?

There are devils in the details of all this, of course—not the least of which is how we help participants who don’t know the difference between a stock and a bond appreciate the nuances of revenue-sharing—but we are long past the point of debating whether more disclosure is needed. And if the hearing last week established nothing beyond that, it was well worth the effort.

- Nevin E. Adams, JD

You can watch last week’s hearing online HERE

“We’re from the Government, and We’re Here To Help”

Despite the variety of advisers, practices, business models, and broker-dealer affiliations at our recent PLANADVISER National Conference, there was a remarkable degree of convergence of purpose in evidence. That was perhaps to have been expected—after all, this was a group of some of the most successful retirement plan advisers in the country. There were, however, a couple of points where perspectives diverged—most intriguingly, IMHO, on the subject of participant advice.

Not on whether or not participant advice is needed, of course—mostly on whether or not they should provide advice as a fiduciary adviser. Both National Retirement Partners (NRP) and LPL have signed on with DALBAR’S Fiduciary Adviser Network (FAN), positioning their advisers to be classified as fiduciary advisers under the Pension Protection Act (see “The Future of the Independent Adviser” at ). Meanwhile, firms like Merrill Lynch, Raymond James, and Principal have taken a different stance; generally either finding the legislative structure around the fiduciary adviser role to be insufficiently clear, or perhaps even unnecessary to helping participants make sound investment decisions (under the Pension Protection Act, the fiduciary adviser role deals only with participant-level device).


Different “Strokes”

As things stand today, it seems to me that both perspectives have merit. Certainly, the PPA’s fiduciary adviser role seems to provide valuable protections for both the plan sponsor and the adviser, offers a structure for review and oversight of the adviser’s services by the plan fiduciary, and affords some additional flexibility in how an adviser may be compensated for those services. Consider that the dominant reason long proffered by plan sponsors for not offering advice is fiduciary concerns and one can quickly grasp the allure of being able to offer assurances on that count.

On the other hand, there are a variety of ways for advisers to offer impactful education, and even full-fledged advice, without running afoul of regulatory prohibitions or having to fulfill the obligations attendant with the assumption of a fiduciary adviser role (which, it should be noted, is quite a separate thing from being an adviser who is a fiduciary), most notably utilizing independent asset-allocation models or embracing a level-fee service approach.

Still, the current “debate” over how to offer advice (or, more accurately, IMHO, how to get paid for offering advice) misses a significant point: It’s not just advisers who think participants need advice, or plan sponsors, or even plan participants themselves. What is most interesting to me is just how eager the Department of Labor seems to be to facilitate that help.

“Far” Reaching?

One of the so-called great “lies” is “We’re from the government, and we’re here to help.” Yet, to this day, I am struck by just how far the government, specifically the DoL, was willing to extend the definition of education—and thus allow participants to get help without causing advisers to run afoul of the advice fee prohibitions in 1996 with Interpretive Bulletin 96-1 (see “How Far Can Education Go Without Crossing the Line?” ). In 2001, they saw yet another opportunity to encourage advice and issued Advisory Opinion 2001-09 , more commonly referred to as the SunAmerica opinion. While requested on behalf of a specific provider, the DoL took advantage of the opportunity to extend their response to include any comparable offering. This allowed the use of independent asset-allocation models without imposing a flat fee requirement, and has now been largely embodied in the computer model exception in the PPA’s fiduciary adviser definition. Just this year, the DoL issued FAB 2007-01, which “clarified” a point for enforcement officers in the field that I’m reasonably sure most plan sponsors weren’t (and perhaps still aren’t) aware of—their liability for the selection and monitoring of the adviser, not the advice (see “IMHO: A Little ‘Free’ Advice”).

But while I think the DoL has long and consistently been supportive of helping us offer advice to participants, there is one thing that they have been just as consistently—and rightly, IMHO—concerned about; advice biased by the compensation of the person making the recommendation. Participants need help, after all—but not in being betrayed by the interests of unscrupulous advisers.

- Nevin E. Adams, JD

Certify Able

A year ago, I wrote a column titled “Alphabet Soup” about the challenges associated with getting—and keeping—professional designations that are meaningful to plan sponsors (see “Alphabet Soup,” PLANADVISER, Fall 2006). However, it’s not as though all certifications or designations are hard to come by—and, unfortunately, there are people out there who are willing to take advantage of people.

Concerns about unscrupulous financial advisers using faux designations to mislead individual investors have resulted in a number of state initiatives to crack down on how these designations are used. And while stories of unscrupulous advisers are not as hard to come by as one might hope, the designation issue has already garnered coverage in the New York Times. The focus of that story was a “Certified Senior Adviser” in the state of Massachusetts who had allegedly taken advantage of clients, notably senior citizens, in promoting inappropriate insurance investments—and who subsequently was sued by regulators in that state.

At this writing, Massachusetts seems to be out in front on the issue—but similar initiatives are percolating in a number of other states. In April, the Secretary of State proposed regulations that became effective June 1, 2007. That new regulation prohibits financial advisers practicing in the state from “using a purported credential or professional designation that indicates or implies that an investment adviser representative has special certification or training in advising or servicing senior investor, unless such credential or professional designation has been accredited by an accreditation organization recognized by the Secretary by rule or order.” The regulation goes on to note that the term ‘senior investor’ shall include a person 65 years of age or older.”

Clearly, the focus of the new regulation is on protecting seniors. Less clearly, but nonetheless based on conversations we’ve had with Massachusetts officials, the regulations aren’t focused on employer-sponsored/workplace plans. Still, there are two issues that have to be of concern for advisers who work with retirement plans with ties to the Bay State. First, there are a growing number of retirement plan participants who are, in fact, older than age 65, and thus “senior investors” under the provisions of the Massachusetts regulation. Second, despite comments on the proposed regulations from a number of retirement plan providers asking that Massachusetts provide a specific exemption for work with retirement plans(1), the final regulations contained no such exemption.

Ultimately, of course, protecting individuals from unscrupulous practices is laudable and well within the mandate of these state officials. Advisers who have worked hard to attain—and retain—professional designations can certainly benefit from the elimination of designation “clutter.” Still, as the various states make their invariably individualized determinations as to how to structure these mandates (and compliance departments struggle to determine how those determinations are to be applied), it seems likely—in the short run at least—that retirement plan advisers, and their plan sponsor clients, will lack some clarity.

- Nevin E. Adams, JD

(1)In comments provided on the proposed regulations, The Life Insurance Association of Massachusetts suggested a new subsection to the law that would read: "This subsection shall not apply to the use of credentials or designations in the context of retirement planning provided or sponsored by an individual's current or former employer."

Rising "Tied"

"In inflation, everything gets more valuable except money."

This week, the eyes of the stock market (and thus the eyes of those of us with 401(k) investments in that stock market) will turn to the meeting of the Federal Open Market Committee—that special subset of the Federal Reserve that determines short-term monetary policy for the nation. The Fed has long—and understandably—been on the alert for signs that inflation might rear its ugly head. Those of us who lived through the 1970s can remember all too well the relentless pressure of wages unable to keep up with prices—and can appreciate the vigilance of the Fed in seeking to keep inflation under control.

In fact, for some time now, the Fed has moved preemptively to head off inflation, or so it claims. But anyone who has actually gone out and bought such basic household necessities as food or gasoline is well aware that the costs of living are climbing rapidly. We may well enjoy a sense of growing wealth as we watch housing prices soar (or did until recently)—but there’s a greater likelihood that you’ve paid dearly for those paper gains in terms of higher property taxes than that you have been able to capitalize on those trends.

Of course the Fed—which is, after all, seeking stability in monetary policy as well as economic growth—deliberately ignores some of the more volatile costs in its evaluation of inflation; notably food and energy.

Still, for those of us who pay to live in the real world, it certainly feels as though inflation—defined by the American Heritage Dictionary as “a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services”—is alive and well. Little wonder that Social Security recipients wait anxiously each year to find out how much their annual stipend will be adjusted for a “cost-of-living” increase.

However, unlike Social Security, there is no annual cost-of-living “adjustment” for retirement savings—no systematic means by which those accumulated savings are increased to offset the increased costs of things like heating fuel, food, and medicine. Ironically, should the Fed detect the insidious signs of inflation, their response would likely be to increase short-term interest rates—a move that, in all likelihood, would result in a drop in stock prices (and retirement savings accounts).

It’s an issue of more than passing significance for retirement savers, of course. After all, managing to replace a targeted amount of preretirement income is of little consequence if, 10 years on, that amount isn’t sufficient to provide for life’s necessities. To their credit, most retirement savings calculators retain an inflation assumption that can help those future projections reflect potential realities. Those cost-of-living numbers probably understate the increase in things like health care and fuel oil (they may, of course, overstate the rate of increase in other items). Worse, those adjustments frequently serve to project a certain annual rate of pay (and deferral) increase that, for a growing number of American workers, is no more than a quaint anachronism.

Whatever the Fed manages to say about inflation this week, retirement savers should be mindful of the reality that the future frequently costs more than the past—but we only have the present to prepare.

Nevin E. Adams, JD

Just Another Day?

This week, I’m going to do something I never thought I would do again.

I’m going to fly on September 11.

OK, so, in the overall scheme of things, it’s perhaps not that big a deal. I know that it’s been six years, that part of our not letting the terrorists win is to go on about our normal lives. I don’t even know anyone personally who died in the attacks, though I know people who do. At the time of the attacks, I wasn’t living in the parts of our nation targeted (although we relocated to the Northeast soon afterward). It’s not like I plan to spend some significant part of the day in prayer or contemplation—and it’s certainly not that I believe for one second that there will be a recurrence of those horrific events just because it’s the sixth anniversary.

I was, however, traveling by air on that fateful day, only to be grounded hundreds of miles away from friends and family (see Never Forget). I know that others were stranded farther away from their loved ones—and perhaps for longer. But it was a time when I wanted—more than I could possibly have imagined at the time—to be with my family. It was a time when people who love each other should have been able to comfort and reassure each other.

Somehow, the notion of once again being hundreds of miles away from my family on that day just seems wrong. Not as wrong as missing a birthday or graduation (I’m still batting 1.000 there)—but wrong, nonetheless. Whatever else we try to make of it, for this generation anyway, September 11 will always be “different.”

Like you, I’ll always have my memories of that day. I’ll never approach getting on an airplane the same way again, for one thing. I doubt that I’ll ever feel as “safe” as I once did, but I also appreciate in a very special way, every day, the love of my family, the support of friends, the joy of being alive—and the responsibility to remember always that there are those whose reunion with their loved ones still lies ahead.

I may be traveling this September 11. But it is not—and should never become—“just another day.”

Peace.

Impact Full

In a business notorious for change, it nonetheless seems fair to say that the past twelve months have been extraordinary ones indeed for financial advisers. In short order, we have had to absorb and assimilate the mandates of the Pension Protection Act, grapple with the portents of qualified default investment alternatives, gird ourselves for the impact of final regulations on deferred compensation plans and 403(b)s—and all this at a time when revenue-sharing practices are drawing an unprecedented level of scrutiny from all quarters.

There is nothing like tumultuous times to highlight the value of, and reinforce the need for, expert help for plan fiduciaries. It is also the kind of challenging environment that tends to separate the chaff from the wheat—that sorts out the committed from the merely intrigued. And, yes, it surely plays to the advantage of a profession dedicated to helping plan sponsors construct the right programs, and participants make the best of them.

That is why, in 2005, we launched our Retirement Plan Adviser of the Year award; to acknowledge "the contributions of the nation's best financial advisers in helping make retirement security a reality for workers across the nation." Today, it is both my honor and privilege to launch the nomination process for our fourth annual campaign to acknowledge the contributions of the very best financial advisers in the nation, both individuals and teams.

Impact Statement

The criteria that underlie the award are simple but impactful; we want to recognize advisers who make a difference through increasing participation, boosting deferral rates, enhancing asset allocation, and/or providing better programs through expanded service or expense management. It is no accident that those criteria also underlie the Pension Protection Act’s designs for defined contribution plans, for only by getting more workers saving in these programs at effective rates, and invested in prudent ways, can they have any real prospects for retirement security.

We will acknowledge the finalists in the December issue of PLANSPONSOR as well as the Winter issue of PLANADVISER, and profile the winners in the March issue of PLANSPONSOR and Spring issue of PLANADVISER. The finalists also will be recognized at PLANSPONSOR’s Annual Awards for Excellence celebration in New York City in March.

It has been our privilege these past several years to lend a hand to your efforts—first via PLANSPONSOR magazine; then via PLANSPONSOR.com, the NewsDash, and this publication; and, more recently, via our education arm, the PLANSPONSOR Institute and our PLANSPONSOR Retirement Professional (PRP) designation. Believe it or not, it was a year ago next month that we officially launched PLANADVISER—and later this month, we will offer our very first adviser-focused conference, the PLANADVISER National Conference, and I hope to see many of you there (but you need to register ASAP, if you haven’t already).

While these awards are designed to recognize financial adviser excellence, we trust the standards they embody will continue to provide a source of inspiration for those who make a difference every day. I look forward to getting to know you, and your practices, better through this process.

- Nevin Adams, JD

You can nominate a colleague, your plan's adviser, or yourself HERE

Sub-prime Time

Here we go again.

I’ve been in this business long enough to call to mind several big financial scandals. Not Enron and WorldCom types—ultimately, those were, to my way of thinking, pretty isolated cases, albeit driven by the motivation that seems to drive all financial scandals: greed and hubris.

However, over the past couple of weeks, retirement savings balances have been buffeted about by concerns about liquidity in the market, triggered by issues regarding institutions that have (apparently) loaned money to people that were based on property values that were projected to go up—when they haven’t. The problem, of course, isn’t just people being overextended on their mortgages (though that is a problem), or the firms that have allowed that situation to occur (though that is also a problem); it’s that the latter have created a whole category of investments that consist of those unraveling mortgage commitments—and lots of us have money tied up in those investments – or impacted by money tied up in those investments - whether we know it or not.

Signs of Trouble

It’s not like we couldn’t see this coming. People have been wringing their hands about the housing bubble bursting for quite some time now. Just like we did about junk bonds (before we called them “high-yield”), derivatives (before we started referring to them as “alternative” investments), and hedge funds (which are also sometimes called alternative investments, but here mainly because, IMHO, many have really been alternatives TO investing, à la betting against the market). Now, I’ll concede that the latter hasn’t imploded yet, at least not on a broad-scale, but the signs are all there, and we’ve already seen a couple “blow up.” But, as for our most recent problem, let’s be honest with ourselves—those who buy into (or take on) something called “subprime” certainly can’t plausibly say they didn’t see the potential for problems.

None of this is inherently bad, of course. Part of the beauty of our free market system lies in its ability to create new ways for innovative minds to raise capital and make money. Where we get into trouble is (a) when everybody “catches on” to the latest idea (thus drying up much or all of the opportunity), and (b) when “they” do so via “leverage”—that is, spending money they don’t have. Now, leverage, too, can be an enabling thing, but when everybody is doing it, well, sooner or later, the people who lend money always seem to want to be repaid—and, generally speaking, when the collateral that supports such investments can least afford that demand.

Not that that rationalization is likely to be of much solace to the retirement plan participants whose accounts are currently taking it on the chin, however. It’s not their fault (unless, of course, they contributed to the problem by taking out a mortgage they couldn’t afford, betting on the continued rise in house prices—just another form of borrowing money you don’t have), and yet they, as investors in and beneficiaries of the investment markets, must ride out the bad as well as the good.

The current “tumult” (we seem to be past the “crisis” stage, at least for the moment) should serve to remind us all of the dangers. You already may be hearing questions from plan sponsors and participants—about what is going on in the markets, about what has happened to their account balances—maybe even about what you recommend they should do about it all.

Questions are good. It means people are paying attention. But wouldn’t it be nice if the people who created these crises did - - - before they got to be the people who create these crisis?

- Nevin E. Adams, JD

PPA's SWAY

These days, the Pension Protection Act of 2006 (PPA) is sometimes referred to as the “Pension Destruction Act.” That’s too harsh an assessment, IMHO, but it certainly has a foundation in reality.

Without question, the PPA (it was just a year ago Friday that President Bush signed the legislation into law) imposed some new—and for many plans, harsh—restrictions on funding and accounting for funding. Additionally, it did so after many of the worst offenders and abusers of the system were already “out” (legislation frequently closes the barn door after the cow has escaped), and it did so at a time when many plans seemed particularly vulnerable, and many through no real fault of their own.

We may never know how many problems were averted by its passage—and by the time its new defined benefit provisions took hold, investment markets, interest rates, and contribution levels had combined to make the problems confronting pension plans much less severe than they were at the time of the law’s passage. Mind you, I’m not prepared to say that it protected any pensions, but it probably didn’t—on its own, anyway—trigger the early demise of many programs, either (though it may have accelerated the deliberations). Moreover, the PPA’s explicit sanction of the cash balance design, by some accounts, has given a new lease on life to that hybrid approach, at least in some market segments.

Defined Contribution Impact

As for defined contribution plans, I think the PPA did some good in putting structure around some of the “automatic” solutions, and, for the very most part, took into account some of the aspects of those programs that needed tending to; notably state wage law preemption and the ability to return those “mistaken” contributions. We now have some discrimination testing relief for plans that adopt the automatic enrollment approach codified in the PPA, and if some find the matching contribution requirement too expensive, the contribution acceleration provision distasteful, or the testing relief unnecessary (current safe harbor plans already enjoy much of that relief)—well, it’s optional, after all, not mandatory. If you like automatic enrollment, but not the PPA’s particular flavor, nothing prevents you from implementing your own version. As for the qualified default investment alternative—well, the DoL was working on this ahead of the PPA. Ironically, passage of the PPA may have actually slowed the timing of this particular enhancement—but we’ll have clarity soon enough.

The PPA’s participant notification requirements have been something of a burden, and almost certainly aren’t the aid to participant clarification that they ostensibly were mandated to provide. As for the concept of a fiduciary adviser—well, there’s perhaps not as much precise clarity there as some would prefer. But we do now understand (from the PPA and FAB 2007-01) that the plan sponsor’s fiduciary responsibility is for the selection/monitoring of the adviser, not the advice provided—and for many plan sponsors (and no doubt many advisers), that’s a welcome clarification. And within the guidelines of the PPA, there is another way for qualified fiduciary advisers to be compensated for their services.

Of course, almost overlooked in all the attention paid to the new tools included in the PPA is the fact that it removed the legislative “sunset” on an enormous number of crucial provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001—EGTRRA—including the Roth 401(k), increased contribution limits, repeal of the multiple use test, and modification of the top-heavy rules.

All in all, there may not be much “protection” in the Pension Protection Act—but, IMHO, there’s still a lot of good to be found there.

- Nevin E. Adams, JD

Incentives Eyed

We don’t have a large yard, but it’s big enough to be “unruly.” Despite my best efforts to ignore the unruliness (winter’s coming, after all), my wife—who thinks about things like having a yard that looks like we were in Cabo for the summer—was of a different mind.

While there are three teenagers living under our roof at present, we long ago realized that we couldn’t rely on them to see that something needs doing, much less to, on their own initiative, undertake to do something about it (dads can be pretty oblivious as well, but teenagers give a whole new meaning to the notion). They CAN, however, be bribed—er, “motivated”—and their mother made them an offer it would be hard to refuse; cold, hard cash. And while it was a sum well short of what we’d have to pay one of the ubiquitous yard services that swarm through our neighborhood, it was a lot of money to cash-starved teenagers. And it appears to be working.

What's In It For Them?

I was talking to an investment analyst this past week, and after a long conversation about automatic enrollment, QDIA prospects, discrimination testing, and how many working Americans were (and weren’t) covered by a workplace retirement plan (even today, less than half are, incredibly), he posed a simple question: “So, what’s in the Pension Protection Act that would encourage an employer to set up a 401(k) plan?”

I pondered that question for a moment before I finally—and somewhat hesitantly—offered, “Nothing, really.” Now, I went on to talk about the things that were in the PPA that might make it easier for plan sponsors who currently offer a program to continue doing so: how design “sanctions” like the automatic enrollment safe harbor could surely help on troublesome aspects like participation rates and discrimination tests; how the emergence of a true, clear definition of a qualified default investment alternative (QDIA) could remove some of the uncertainty behind some of the toughest decisions for plan sponsors; how access to professional help via the new financial adviser role might make it easier for participants to make better decisions. Still, when I stopped to think about it, I couldn’t imagine that any of those “new” approaches would have any sway in convincing an employer who didn’t already offer such a program to do so.

That’s a real problem for the retirement security of this country, of course. As I noted above, the Bureau of Labor Statistics says that only about 43% of working Americans are covered by a workplace retirement program today. While we rightly spend much time and energy worrying about the savings habits of those 43%, we are literally missing the big picture if we ignore the reality that a majority of working Americans lack the support of the kind of retirement programs many of us take for granted.

Why Knots?

There are reasons for employers to offer these programs, of course—potential workers care about them, and current workers often stick around for these benefits. Employers do receive some tax benefits for offering them as well, though in many cases, perhaps not enough benefit to counter the costs associated with sponsoring the program, not to mention the fiduciary risks attendant with choosing to do so.

IMHO, we tend to take for granted that employers will “do the right thing”; that they will simply care enough about their workers to take on these additional costs and risks. Fortunately, many do—but just as obviously, while they can clearly see the need, like my teenagers, they have other priorities (in fairness, those priorities frequently include “little” things like meeting a payroll). There are those in Washington who already are taking a hard look at the numbers of working Americans not covered by a workplace program and looking for ways to balance that out, to “level the field.”

Unfortunately, for some, that doesn’t involve encouraging more employers to get in, it means developing alternatives that don’t require the involvement of an employer; and some, I’m sure, would be perfectly content to take the existing enticements, such as they are, away altogether and—in an ironic display of nonpartisanship—rely solely on individual initiative or the support of the federal government. Either direction would, IMHO, serve only to encourage employers who are currently providing such programs to rethink that commitment, and the rumblings certainly do nothing to engender interest on the part of employers who aren’t currently doing so from changing that position.

Still, we can all attest to the tremendous impact of workplace retirement plans in helping ensure individual retirement security, whether it is through workplace education, the employer match, and even “peer pressure” in terms of encouraging participation. What we seem to have lost along the way is a sense that we need to provide incentives to employers to make that commitment.

Failing those incentives, is it any wonder that so many are still on the sidelines?

- Nevin E. Adams, JD

For the People, By the People

Last week, no fewer than a dozen industry trade organizations put their collective heads together and tried to help the Department of Labor—which has been working on a project regarding fee disclosure, and has asked for input—put together some workable principles on retirement plan fee disclosure (see Retirement Associations Submit Fee Disclosure Recommendations to DoL). Also last week, and perhaps not coincidentally, Congressman George Miller (D-California) did what he has been making noises about doing for some time now: He introduced a bill that would put the force of law behind better retirement plan fee disclosure, both to plan sponsors and plan participants (see Representative Miller Introduces Fee Disclosure Legislation). Miller’s 401(k) Fair Disclosure for Retirement Security Act of 2007 would go beyond mere words, however. It would mandate the inclusion of at least one “lower-cost, balanced index fund” on retirement plan menus.

It’s hard to credibly argue that we shouldn’t be telling participants how much they are paying for these retirement programs. On the other hand, we—rightfully, and this was a big part of the combined trade organization communication—don’t want participants to focus obsessively on fees alone. In this business, as in life generally, sometimes you get what you pay for, after all.

Where that leaves us, of course, is with a need to provide participants even more information about their retirement plan accounts than they receive at present. Now, we’re already burying them in paper—enrollment kits, prospectuses, fund information sheets, 404(c) communications, black out notices. Moreover, thanks to the Pension Protection Act (PPA), this year we began providing quarterly diversification notices (we’ll set aside for a minute the fact that we had to begin doing that before we had final clarity on exactly what was supposed to be in those notices). I have yet to talk to an adviser, third-party administrator, or plan sponsor who doesn’t think that we long ago passed the point of information overload—where participants are absolutely just dumping all of this paper straight into the waste basket. Yet, despite this knowledge, our solution is to create some more “information.”

Even if we weren’t at that stage, however, think about where we are as an industry with participant involvement with these accounts: automatic enrollment and contribution escalation, defaulted investments. We are rapidly entering a period where it’s going to be quite “fashionable” for workers to be even less involved with their retirement accounts than they have ever been. The mainstream media is already touting these “automatic” programs as something workers ought to be looking for and asking about. Kathy Kristoff, a personal finance columnist in the LA Times, last week said, “If you're lucky enough to have the newest kind of 401(k) plan, experts say you're off to a good start even if you don't lift a finger.”

Do we really think that this new generation of participants that didn’t even have to “lift a finger” to join the retirement plan will pay any attention to the current plan disclosures—much less the new ones that appear to be looming?

That won’t keep us from pushing for more and better disclosure, nor should it. At some level, whether participants read it or not, there’s just something about making people put information in writing—and knowing that SOME people WILL read it—that helps keep things on the “up-and-up.”

But, IMHO, we’ve had far too many “solutions” created by regulators and legislators—by lawyers for lawyers, if you will—and they’re not doing a bit to help the people for which they are ostensibly intended (here’s a hint: If a disclosure requires a footnote, it’s too complicated). At the risk of greatly oversimplifying the challenge, I wonder if we couldn’t develop an “elevator speech” for these programs, boiled down to the essence of what a participant really needs to know—deliverable in the space and time of an elevator ride.

I’ll bet we could do it. I’ll bet some of you have.

- Nevin E. Adams, JD

Note: If you’ve got an elevator speech for participants; something that gets to the heart of the reason for savings, the selection of appropriate investments, and the fees associated with those decisions – please share it with me at nevin.adams@plansponsor.com. We’ll share the best in a future issue of PLANSPONSOR magazine, anonymously if you – or your compliance department - prefer.

Lies, Damned Lies, and Statistics

I am fortunate enough to have access to a vast array of studies, research, and surveys about this business. Even more fortunate to have access to a PLANSPONSOR research arm that provides an opportunity not only to gather and analyze, but to pose our own questions to a remarkably diverse audience. Still, as Mark Twain once famously wrote, “There are three kinds of lies: lies, damned lies, and statistics.” (1)

We recently ran coverage of a survey that spoke to trends among defined benefit plans. That engendered the following response from a reader:

Isn't it interesting how perspective can rule the most simple things? The article you refer to that shows defined benefit plans decreasing in number is such a case. Mercer deals with the larger corporate plan sponsors. Their plans are underwater for numerous reasons and are being terminated in wholesale lots. On the other hand, small companies are making defined benefit plans the plan du jour. There are several reasons for this; larger tax deductions, demographics, insecurity with Social Security, the investment experiences of 1999-2002, the desire for a "guaranteed" benefit, etc. Our company is the largest pension administration firm in Florida, and we have set up five defined benefit plans to every three defined contribution for four consecutive years. Our experience has been shared by virtually all TPA's in the small-company market all over the country.

Now, I have no independent validation of that reader’s claims, but I heard from a number of advisers and providers that support smaller employers that the rumors of the defined benefit plan’s demise is, to draw on another quote from Mr. Twain, “greatly exaggerated”.

In our business, we must constantly guard against the favorable positioning of some survey results vis-à-vis the interests of a sponsoring organization; or the extrapolation of too much conclusion from too small, or unscientific, a sampling. Generally speaking, I favor sharing as much information/insights as possible—with as much full disclosure about the size of the sampling and/or the interest(s) of the sponsoring organization as possible. In our coverage, we try very hard to position—as high in the story as possible—the size of the sampling, the sponsoring organization, and where it seems applicable (and not obvious), some indication of possible motivation in putting out the information. It’s not that they necessarily would be pushing a specific result—sometimes it just influences their perspective on the proper conclusion to be drawn from the data.

Surveys Say

The challenge, of course, is that some data are simply more available. Larger providers tend to have larger client bases, and client bases of larger clients, to draw on, and/or larger budgets to pay other organizations to gather that information (generally from plans that fit their targeted plan demographics). Moreover, the use of “averages” frequently, if unintentionally, obscures the reality in small samplings. And when averages are averaged—well, it’s Katie, bar the door!

In my experience, human beings are inclined to focus on surveys that reinforce their own version of reality, rather than one that challenges it. Still, market trends are a significant motivator of plan sponsor behavior. That’s not illogical, IMHO—in an environment where complex financial decisions fraught with personal and professional risk are the order of the day, “what everyone else is doing” can offer a compelling reality check. But only if the reality is real—and not just “lies, damned lies, and statistics.”

- Nevin E. Adams, JD

==================================================

When considering data that purports to offer insights, it’s worth knowing:

Who sponsored/conducted the survey?
What are they selling?
Is the conclusion supported by the data?
Does that conclusion “fit” with those drawn by similar surveys?
How unbiased is the survey sampling?
How scientific is the survey sampling?
How similar is the survey sampling to your perspective/size?


(1) While the original quote is attributed to Benjamin Disraeli, Twain popularized it in the U.S. in “Chapters from My Autobiography.”

Question Marks

Without question, asset-allocation solutions—particularly target-date fund solutions—are well on their way to becoming a dominating force on retirement plan menus. More than three-quarters of the roughly 5,000 respondents to last year’s Defined Contribution Services Survey already had one of these options on their menu.

Moreover, the popularity of these offerings has resulted in a burgeoning number of choices, with what seems like a new introduction every other week, and by some of the most well-known and highly regarded names in the asset management business.

Having said that, the notions of what constitutes an “appropriate” asset allocation, much less an appropriate asset-allocation fund—or fund family—are varied, to say the least. Almost as varied as the number of choices, in fact—and it appears that those notions are shifting as well. These “moving” targets (see “Moving Targets”) will keep us all on our toes for the foreseeable future—and I suspect that we will all bring to that evaluation process certain grounding biases as we evaluate the alternatives, whether we admit to them or not.

Here are some of mine:

Stock up. Longer life spans suggest (to me, anyway) a need for more equities, longer, than traditional asset-allocation models seem to call for. At the moment, the primary battle for the “hearts and minds” of target-date design seems to focus on the amount—and motivations for the amount—of equities in the portfolios, particularly the further one goes out on the time horizon. The equity markets have been kind of late (to say the least) to those who have leaned heavily on them. Some target-date offerings have beefed up their equity allocations; others have grown increasingly critical of those decisions. The bottom line: I find that many of the more “conservative” asset-allocation strategies look very much like the traditional asset allocations of 40 years ago. That was then….

"Go long" in matching matching participants with target-dates. Although participants are already talking more about working past age 65, the current logic associated with picking a target-date fund still largely focuses on when you will attain 65. Even though most of the literature speaks to “retirement date” as the target, I think it’s a good idea to round “up” when it comes to picking the right choice.

Risk evaluation shouldn’t be a one-way street. When it comes to discussions of risk, I find that the risk of outliving money isn’t weighted as strongly as the risk of losing money. Now, this is a tricky thing because people tend to worry hugely about the latter until they get to a point where the former is a reality—and then, of course, it’s too late. This is exactly why participants (and plan sponsors who make default investment choices for participants) lean toward stable value and money market fund choices (see “Other People’s Money”). Now, I’ll admit there’s a big difference between going 100% stable value at age 30, and going 80% fixed income at age 60. But I think some of those conservative allocations don’t contemplate actually having to live on those investments for a quarter century—though once you get to age 65, the odds are pretty good.

Bond funds don’t act like bonds. Consequently, those late-cycle diversifications into bond funds don’t feel like they accomplish the same thing as diversifying into bonds. It’s one thing to pull some gains out of the stock market and invest in a security that stands a reasonable chance of returning your principle at a definite point in the future with scheduled interest payments along the way. Something else altogether, IMHO, to make that same investment in a bond mutual fund. Less volatile than stock funds, perhaps—but also more volatile than bonds, in my experience.


No doubt you have biases of your own, perhaps even some of the above. No doubt at least some of you would take issue with some of mine. I hope so. Clearly, no one person or firm has all the answers, and just as clearly, the ones who think they do—probably don’t. What’s important is that we continue to ask the questions, challenge the assumptions, doubt the “common wisdom.”

Ultimately, the quality of the answers lies in the quality of the questions—and the people asking them.

Nevin E. Adams, JD

Other People's Money

I was on a panel at our recent Plan Designs conference, and the topic of qualified default investment alternatives (QDIAs) came up. There was discussion about the Department of Labor’s proposed regulations on the subject; some observations about when we might expect to see final regulations; and ruminations from co-panelists Fred Reish and Mike Barry about ERISA’s embrace of the concepts of modern portfolio theory (MPT), and the importance of capital accumulation rather than capital preservation in making “appropriate” investment choices for participants that hadn’t, for whatever reason, elected to make their own.

Then, a plan sponsor in the audience raised her hand and shared the experience of her plan—shared how they had carefully considered the alternatives of a stable-value investment alongside an asset-allocation alternative, and how they had decided on the former, and did so just before the market tanked in 2000. Her perspective was simply this: If they had chosen the asset-allocation alternative—chosen the option that many (most?) experts say they should have—people would have lost money.

These days, I think it is fair to say that “common wisdom” would call for a different decision. In fact, the expert panel went on to basically lay out all the reasons why that was, if not a bad decision, at least not the one that ERISA’s prudence standard would seem to call for.

Stable "Values"

I understand the logic and rationale behind that perspective; and frankly, IMHO, most of the admonitions to broaden the DoL’s proposed QDIA definition to include stable-value choices seem self-serving, at best. We all know the issues with stable value—it’s ill-diversified (at least from the standpoint of the participant investor, though I find that the “single asset class” labels are generally not precisely accurate), pricey, frequently layered with early withdrawal penalties and/or restrictions, and anything but “guaranteed” (the way the old GIC label suggested). Still, I suspect that, for most of the participants that choose the option (and plan sponsors who choose default investments for participants), stable value provides what they are looking for—a return of their principal investment along with some stated rate of income. Simplistically, a bird in the hand, rather than two in the bush.

That doesn’t mean that stable value will gain the Department of Labor’s (DoL) official endorsement as a QDIA, of course—and, if stable value fails to make that list, it certainly will diminish its allure as a default choice (little wonder that the stable-value industry is up in arms, and that the mutual fund industry, which stands to gain significantly by the apparent endorsement of target-date solutions, has weighed in on the other side). That point of contention notwithstanding, current trends certainly seem to favor the adoption of asset-allocation solutions, rather than stable value, as default investments. Let’s face it: There’s a definite allure to being able to match a defaulted investment choice with the retirement date of a participant—a one-for-all solution that nonetheless seems at least somewhat customized. Finally—and for the lawyers, no doubt, sufficiently—ERISA’s concepts of investment prudence may well presume a certain reliance on the principles of MPT, ultimately demanding an asset-allocation solution.

There remains, however, IMHO, a case for a potentially different result when it comes to making decisions about “other people’s money.” A solution that doesn’t require a plan sponsor to explain to participants about MPT, or to offer a rationalization about timing and the markets—and one that, certainly on a net basis, might provide a reasonable return compared with the relative volatility of an asset-allocation alternative. I’m not saying that that decision doesn’t have to pass ERISA’s muster, or that it doesn’t have, as outlined above, problems of its own. I am saying, however, that the plan sponsor is clearly responsible for the prudence of these default investments, and that they must therefore ask themselves, “Do I think that this default is prudent for the likely term of its investment in this plan?”

And if they can make a case for the prudence of that decision, then, “common wisdom” notwithstanding, I think they have a case.

- Nevin E. Adams


For some interesting perspectives on the inclusion of stable value as a QDIA, see “SURVEY SAYS: Should There Be a Stable Value QDIA?”

See also “Default Ed”

"Might" Makes Right?

Last week the Government Accountability Office (GAO) published a 67-page report titled “Conflicts of Interest Involving High Risk or Terminated Plans Pose Enforcement Challenges.” In announcing the results of that report, Congressmen George Miller (D-California) and Ed Markey (D-Massachusetts), who had commissioned the report, issued a press release claiming that “Undisclosed Conflicts Reduce Pension Plan Returns,” and that “Workers Likely Bear Brunt of Lower Returns in the Form of Reduced Pension Benefits.”

The gist of that report: “[P]ension plan consultants assisting significant numbers of pension plan sponsors may have conflicts of interest, as a result of their affiliations or business arrangements with other firms that could affect the advice they provide to these sponsors.”

However, let me draw your attention to two words in that long sentence: “may” and “could.”

That’s right, after drilling down into the specific firms identified in a Securities and Exchange Commission (SEC) report two years ago (see “IMHO: Disclose Sure?”), the GAO determined only that pension consultants might have a conflict of interest that could affect the advice they provide to plan sponsors. Or, one is tempted to add, they might not.

The SEC report (see “Staff Report Concerning Examinations of Select Pension Consultants”) continues to be dredged up and referenced in media reports as suggesting that “more than half” the pension consultants examined by the SEC had potential conflicts of interest. What is frequently overlooked in that comment is that we’re talking about 13 of 24 firms (the SEC said that 1,742 firms under its oversight provided pension consulting services) – and even then, the SEC’s report said only that the “duality” in the customer base “may create a conflict of interest.”

Still, the most recent report notes that those 13 consulting firms had over $4.5 trillion in assets under advisement and, further, that a sampling of defined benefit plans “associated with” those firms had total assets of $183.5 billion. By any measure, that’s a lot of potential influence.

Performance Standards?

Now, if the report had left it there, it would have been just another expenditure of taxpayer dollars directed toward a fairly obvious result (though the GAO reports are generally very well-researched and informative in describing the historical and legislative background of the issues they cover). However, the GAO report went further – claiming to have found a difference in annual returns between the DB plans who used consultants with those potential conflicts, and those who did not – a 1.3% difference in annual returns, to be specific.

While I commend the GAO for taking the time and effort to see if a difference in result could be quantified, I have to say that I found their conclusion to be something of an extrapolation based on an assumption, founded on a premise – and thus undeserving of its appearance in the report. The GAO itself acknowledged the limitations of their analysis, noting that, “because many factors can affect returns, and data and modeling limitations limit the ability to generalize and interpret the results, this finding, while suggestive, should not be considered as proof of causality between consultants and lower rates of return.” (1) Indeed, consultants offer many types of guidance to pension plans, guidance that is not always solely oriented toward providing the very highest rates of return.

The GAO, again to its credit, acknowledged that the Department of Labor’s Employee Benefits Security Administration (EBSA) “noted a number of concerns about our statistical analysis and in particular our econometric analysis that suggests a negative association between consultants with undisclosed conflicts of interest and rates of return on assets. EBSA expressed important cautions that should be considered when interpreting our results, including some data limitations and our use of an estimate for our investment returns variable.”

Additionally, while the GAO claimed to have found a return differential between plans that were associated with the potentially conflicted consultants and those that relied on other firms, they “did not find significant differences in returns for those plans that had associations with both types of consultants.”

So - there are questions about the assumptions employed, the data itself, proof of the existence of a real conflict of interest that might have resulted in tainted guidance, doubt that the result measured – absolute performance results – would be appropriate under the circumstances - oh, and no apparent difference in the performance results of DB plans that worked with potentially conflicted AND ostensibly unconflicted firms.

As for the impact of all this on retiree benefits and pension funding, the GAO said that EBSA “emphasized the view that it is primarily the failure of plan sponsors to adequately fund pension plans causing plan underfunding problems rather than poor investment advice from self-interested service providers.”

Ultimately, IMHO, we’re left with more questions than answers – loose allegations predicated on tenuous assumptions – and the certainty only that consulting conflicts of interest may exist and could, if present, result in a difference in performance results. That, and a few hyperbolic headlines that, IMHO, cast a broad net of overly generalized assumptions.

If, indeed, there are real conflicts of interest, it’s time we identified them and ended the practice(s), once and for all. No ifs, ands, or “mights” about it.


- Nevin E. Adams, JD


(1) Among the caveats in the report about the assumptions employed were: the use of a “potentially unrepresentative sample of pension consultants to identify the pension plans included in our investigation that therefore limits the ability to generalize the results. A few pension consultants that had significant conflicts of interest that impacted their activity could very well drive the observed negative relationship. Further, the imbalance between the large number of plans associated exclusively with conflicted consultants and the small number of those that were not raise additional statistical issues and limits the ability to generalize the results. Lastly, given the short time period analyzed, it could be possible that some plans’ returns were abnormally low due to their investment strategies, and would have higher returns had the time period analyzed been lengthened.”

Fighting Words

“[T]he complaint is a rambling 38 page collection long on legal argument, public policy rhetoric and repetition, but vague in its allegations of facts which might be relevant to the claims alleged.”

With all the tact of a law professor dressing down a first-year student, U.S. District Judge John Shabaz of the U.S. District Court for the Western District of Wisconsin last week dismissed one of the so-called 401(k) revenue-sharing lawsuits brought by the St. Louis-based law firm of Schlichter, Bogard & Denton – and did so in just 18 pages. And he did so “with prejudice and costs.”

It was the second such case to be dismissed. In an even more succinct dismissal in February (two-pages), U.S. District Judge John Darrah said that the 401(k) participants in the Exelon Corp. plan failed to make a "link between the administrative fees they were charged and their market-based losses" (see Court Tosses 401(k) Participants’ Request for Investment Losses Relief).

Not that there weren’t elements of plan structure that might raise eyebrows in some quarters in the most recent case—the agreement between the plan sponsor (Deere & Co.) and the provider (Fidelity) to limit the fund menu to funds managed by Fidelity, for one thing (23 of the 26 funds on the menu were Fidelity’s). And then there is the judge’s matter of fact assertion that “Defendant Deere could have negotiated lower fees with Fidelity Research, or could have selected different funds from different providers with lower rates but has made no effort to do so.” One could readily imagine those exact words being uttered as a stark condemnation of a fiduciary that had failed to live up to its duty—but this court recounted it as a statement of fact, nothing more (and, for the record, there’s no fiduciary bar to doing what Deere did, so long as their motivations were solely in the best interests of plan participants/beneficiaries, and the fees and services so obtained were reasonable). Besides, the plan did offer access to a brokerage window. If participants wanted something beyond a Fidelity offering, they could tap into some 2,500 other alternatives.

Reasonable Doubts?

Furthermore, IMHO, Judge Shabaz was too willing to conclude that, since Deere participants were paying the same for their mutual investments as other investors, the fees must be reasonable. On the surface, the fees weren’t obscene—fees ranged from .07% for the Spartan Fund to 1.01% for the Diversified International Fund, according to the ruling. Still, it’s one thing to conclude that those fees were reasonable; quite another, IMHO, to assume that they are reasonable simply because others (and retail investors, to boot) are willing to pay them.

Still, Shabaz was clear in refuting the notion that the plan had any obligation to delve into the specifics of any revenue-sharing arrangement (“recent proposals to amend the regulations…to require revenue-sharing disclosures in annual reports make it apparent that present regulations do not require it”), and clearer still in rebuffing the notion that there was an obligation to share those details with plan participants (“Nothing in the statute or regulation directly requires such a disclosure”). Additionally, Shabaz concluded that the fee disclosures included in the Summary Plan Descriptions (SPDs) and prospectuses were sufficient for participants to make informed investment decisions—or at least that requiring more would “require judicial expansion of the detailed disclosure regime crafted by Congress and the Department of Labor pursuant to its statutory authority.”

While he acknowledged that some of the issues raised were undergoing reconsideration (1), when all was said and done, he found no merit in the claims, concluding in effect that it appeared “beyond a reasonable doubt that the plaintiffs can prove no set of facts in support of the claim which would entitle the plaintiffs to relief.”

One should be cautious in drawing too many conclusions from this result, of course. In the same way that lawsuits contain only one side of the situation, dismissals all too often shuttle aside potentially triable issues, not because the issues aren’t there, but because plaintiff’s counsel didn’t make an effective presentation. Still, on the issue of revenue-sharing disclosures, I think Shabaz got it right.

When the cases were first filed I, perhaps like many of you, was no doubt surprised that these kinds of allegations were applied to some of the largest 401(k) plans in the nation—plans that, by any reasonable assessment, probably had the staff and plan-size “clout” to get such matters “right.” Of course, they also had the size that makes for “deep pockets” and public brand(s) that typically eschew the kind of publicity that accompanies a lawsuit and facilitates a quiet settlement.

This time, however, it seems that they have a willingness to fight back.

- Nevin E. Adams, JD

(1) “A review of the report confirms that the revenue sharing issue raised by plaintiffs’ complaint is a matter of policy concern within the Department of Labor. It also unequivocally confirms that present regulations do not require disclosure of the information.”

Caveat Emptor

A couple of weeks ago my better half told me that she thought it was time that we traded in two of our aging vehicles – one a car that is too small for our family, the other a van that now seems too big for all but cross-country trips – for something in the middle. I was amenable to the idea – until she mentioned that she didn’t think we needed to buy a new vehicle as a replacement.

If you have ever in your life purchased a “pre-owned” anything, you’ll appreciate the dangers inherent in the principle of caveat emptor, literally “let the buyer beware.” That’s why, to this day, the notion of purchasing a used car practically causes me to break out in cold sweats. Not that lemons don’t roll off the new car lots every day – but there, at least, it seems that your odds are better – if not in terms of product, at least of obtaining satisfaction if something doesn’t work out.

Buying a used car is, of course, as much art as science – particularly if you aren’t mechanically inclined. That’s why it has become fairly common to enlist the support of a trusted mechanic to assess the reliability of a potential vehicle purchase. Of course that works only if you actually HAVE a trusted mechanic to rely on. In my experience, the only way – outside of a personal relationship - for a mechanic to have earned that trust is for you to have spent a lot of time at the garage (which, of course, may be why you are looking for a different vehicle in the first place).

Plan sponsors are increasingly looking for guidance on what constitutes reasonable, and – spurred by the flurry of recent 401(k) plan lawsuits, and the increasing level of scrutiny applied by regulators and lawmakers – have, logically, tended to be dominated by a focus on fees.

It’s hard to argue with the “clarity” of that focus, but what do you think would be the result if my used car purchase used cost as the only criteria? All things being equal, cost may be a perfectly adequate point of differentiation, but all things are seldom “equal”. When it comes to used cars, common sense dictates that a vehicle in better condition could well be worth more than an identical make and model that has been handled roughly. And we all know of “cheap” car purchases that have more than made up for that initial price differential in terms of subsequent trips to the repair shop.

Things are even more complicated with retirement plans, where plan design flaws are often obscured, and where subtle restrictions and operational limitations don’t appear until well after that finals presentation. Fortunately, ERISA doesn’t require “cheapest.” However, it does call for plan fiduciaries to make decisions that are solely in the best interests of plan participants and beneficiaries, to ensure that those decisions culminate in the selection of services (and fees for those services) that are “reasonable” – and to do so with the insights and perspective of an expert in such matters, or to enlist the support of those who are.

Failing that – “caveat emptor’.

Nevin E. Adams, JD

Moving Targets

In nearly 30 years working with employer-sponsored retirement plans, I am hard-pressed to call to mind a product innovation that has been adopted with as much vigor as the current generation of target-date funds. In PLANSPONSOR’s 2006 Defined Contribution Survey, more than three in four of the nearly 5,000 responding plans had a risk- or target-date-based option on their menu – compared with “just” 54% in the prior year’s survey.

There’s being on the menu, of course, and there’s being chosen from that menu. Still, in the 2006 survey, roughly 25% of participant balances, on average, were already invested in such options – and, on the median, 15% - and this well ahead of the Department of Labor’s tacit enhancement of these vehicles as the default investment vehicle of choice. All in all, it would appear that participants have more access to such choices and are beginning to wake to the simplicity of an investment choice that requires referencing little more than a birth certificate (many still make the case that a single investment allocation approach cannot possibly be suitable for each and every participant who plans to retire in the year 2040).

Moreover, the investment management industry has responded to the opportunity with enthusiasm. One need consider only the number of new offerings introduced in 2007 alone to appreciate just how much more choice is available than was the case the last time I penned a column on the topic (see “Style Conscious,” PLANSPONSOR, September 2005). That’s a very positive development for the most part – after all, a lack of choice was, in the very recent past, a cautionary note of consideration for plan fiduciaries. Additionally, as the choices have expanded, competition (not to mention a renewed emphasis on fee transparency) seems certain to provide a pricing discipline that surely must be applied by fiduciaries, certainly in a “just pick one” fund alternative.

Philosophical Differences

Our free market also has served to bring to the fore a dazzling array of differences in basic asset allocation philosophy. There are compelling arguments being made for allocations that are heavily laden with equities at retirement, while others embrace a more “traditional” fixed-income bent, and still others seek to mirror the allocations in evidence among large defined benefit programs (which themselves are undergoing some fairly radical shifts). These competing notions – and seemingly everything in between – are still often “cloaked,” certainly in the case of target-date offerings, behind names that are frustratingly similar. All claim to be focused on helping the investor achieve retirement security, while minimizing risk – that of running out of money too soon, or of not having enough to run out of in the first place. They can’t ALL be right, surely.

On the other hand, in the midst of all this burgeoning interest, it also has been interesting to watch some of the industry’s more revered asset allocation fund pioneers reinvent and/or rejigger their strategies, their glide paths, the logic that underpins their asset allocation philosophy.

It’s impossible at this point to say who is “right,” of course (perhaps even harder to say that a single investment allocation approach is suitable for each and every participant who plans to retire in the year 2040). Still, IMHO, the industry’s willingness to continue to contemplate and embrace change in these glide paths bodes well, I think, for the intellectual rigor that surely must attend their emergence as a ubiquitous presence on defined contribution plan menus.

What that also means, of course, is that plan fiduciaries will be similarly challenged to keep pace.

- Nevin A. Adams, JD